Asset management assessment (AMA)

We first implemented our AMA approach to assessing capital maintenance expenditure when we set the draft baseline in December 2008. We explained our approach in PR09/23, ‘Asset management assessment (AMA) and baseline setting’ (January 2009). We then providedfurther information in PR09/32, ‘Capital maintenance and asset management assessments (AMA) for draft determinations – technical note’ (August 2009). Our approach is based on the asset management plan assessment process (AMPAP), developed jointly with the water industry in light of experience from the last price review. The criteria for our assessment fall into the main asset management planning areas of:

• stakeholder engagement; • governance, policy and strategy;

• achieving an optimum balance of risk to service and costs.

We have used a symmetrical approach that creates incentives for companies to provide robustly justified plans that are proportionate to proposals for increased activity and costs. The approach also allows us to challenge historic levels of activity and expenditure where this is appropriate. We have used the company expenditure

proposals for 2010-25 and the five years of actual and predicted expenditure for 2005-10 as the starting point for our analysis. This takes account of the most recent evidence on expenditure trends and growth in the asset base. It is, however, only a starting point to the analysis from which we assess planned increases or reductions.

We expected companies to have developed their proposals for capital maintenance within the context set by their SDS. We looked to the business plans to demonstrate a robust risk-based derivation of an economic level of capital maintenance for 2010-15 and beyond. We have challenged companies’ proposals if they have been unable to demonstrate that increasing activity is needed to secure levels of service or that customer support justifies the increased costs.

Our AMA for companies’ final business plans is a full assessment of the technical and managerial processes applied in developing their capital maintenance business plan submissions. It takes into account both the quality of the technical data and the

processes applied, and the quality of the decisions made. This allows us to produce an overall ‘AMA score’ from a figure for each sub-service.

For our final determinations, we have placed emphasis on:

• how companies have balanced the competing pressures for maintaining a stable profile of risk to service and serviceability;

• the upward pressure on prices; and

• the need to deliver good value to customers.

The AMA score does not just reflect a technical application of asset management

planning principles, but our overall assessment of the appropriateness of and confidence in the plan for capital maintenance as a whole.

Figure 10 shows the total industry level of capital maintenance expenditure and

illustrates the principle components in our assumptions for price limits. These figures are net of companies’ and our assumptions for capital efficiency. We explain our

Figure 10 Total capital maintenance expenditure (post efficiency)

Our AMA approach does not automatically challenge all proposed maintenance

expenditure. It is clear that a substantial proportion of activity needs to continue into the next period in order to maintain the capability of assets to continue to deliver services to consumers.

Many companies have demonstrated that the levels of recent activity and expenditure are a sound basis for the future. This can be seen from each company's output

performance and the robustness of its planning approach for the future. However, in some cases the evidence was less convincing.

If companies have proposed increases in expenditure, we have challenged adjustments for our price limit assumptions using the AMA assessment. In other cases, companies have proposed reduced activity and expenditure. Here, the AMA approach allows us to provide companies with incentives to maintain services at lower cost.

We applied the AMA challenge to about £4.2 billion of the proposed total capital maintenance programme, with exceptional expenditure items (see section 4.3.3) representing about £800 million of proposed expenditure.

By sub-service, the capital maintenance investment included within our baseline assessments are set out below.

• For water infrastructure investment we have assumed an increase in expenditure of more than £800 million, up 36% compared with that assumed at the 2004 price review. This reflects consolidation of work on water distribution assets driven by

Capital maintenance – industry total

0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 Company FBP Ofwat FD Cap ital maintena nce e xpend iture in £ m illion

Subject to AMA challenge Exceptional items Not subject to challenge

Capital maintenance – industry total

0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 Company FBP Ofwat FD Cap ital maintena nce e xpend iture in £ m illion

Subject to AMA challenge Exceptional items Not subject to challenge

water quality and leakage considerations within capital maintenance. Also included is £200 million of investment for improvements in the consumer

acceptability of water that aims to reduce the number of incidents of discoloured water.

• Water non-infrastructure investment expenditure has increased by more than £560 million, up 19% compared with that allowed at the 2004 price review. This focuses on maintaining the water quality compliance benefits achieved through past price reviews as well as funding the first time replacement of domestic meters originally installed during the mid-1990s.

• Sewerage infrastructure investment has seen an increase of more than £140 million, up 11% compared with that allowed at the 2004 price review. This focuses on maintaining improvements in service benefits for sewer flooding. • Sewerage non-infrastructure expenditure has increased by more than £670

million, up 17% compared with that allowed at the 2004 price review. This

focuses on maintaining the environmental compliance benefits achieved through past price reviews.

The overall capital maintenance increase of 21% uplift for 2010-15 builds on the 22% uplift increase we assumed at the last price review. Capital maintenance submissions have improved both in terms of the quality of evidence presented and in terms of the application of planning approaches applied through the capital maintenance planning common framework (CMPCF).

This means that in the last two price reviews, we have seen overall increases in capital maintenance expenditure of nearly 50% compared with the 2000-05 level. We recognise the need for such increases to maintain services to customers and to consolidate the benefits from previous improvement programmes. However, we must question whether we are now approaching a sustainable level of capital maintenance for the future. We recognise that the industry as a whole has improved its understanding of asset

behaviour and investment needs and that the common framework approach has served the sector well, contributing to a much-improved understanding of investment needs. As we look forward to the setting price limits in the future, we see a need to reappraise the common framework approach and develop potential improvements, particularly in the areas of risk management, programme optimisation and the balancing of service benefits. In particular, it is important that companies improve their understanding of the benefits derived from investments already delivered in order to inform future decision processes. We see a considerable difference across the industry in the unit costs of delivery of each sub-service (particularly in the areas of water infrastructure and sewerage non-infrastructure). It is unclear from current analysis whether these

differences are driven by genuine asset needs or through differences of efficiency and effectiveness.

At the same time, we want to ensure that efficient and effective companies are

recognised and rewarded through the price setting mechanism, while incentives are in place to encourage all companies to improve their asset management and service delivery.

We will continue to work closely with the industry before the next price review framework is implemented to develop both the common framework and the AMA approach in a timely, open and transparent way.